Think you don’t need an entity if you are “just a consultant,” “just a contractor,” or “this is just your side gig”
Most small business owners understand that forming an entity with the Secretary of State and properly maintaining it, will protect them from personal liability for their business debts. Despite this knowledge, many entreprenuers may think that the cost and time of forming an entity is not worth it, because they are “just a consultant,” “just a contractor, ” or “this is just their side gig.” In fact, according to the Small Business Administration, the great majority of all businesses without paid employees are sole proprietorships.
However, when considering that if you get sued, not only everything you have worked for in your business, but also every single non-exempt personal asset you own is at risk, in many instances the benefits of forming and maintaining an entity will far outweigh the costs.
In our litigious society, this scenario is not so far-fetched. The purpose of this post isn’t to dissuade you from starting or continuing your small business, but to help identify a risk that can be mitigated relatively easily and inexpensively. When it comes to protecting personal assets from business liabilities, as Ben Franklin said, “an ounce of prevention is worth a pound of cure”. As with most legal issues faced by small business owners, there is no one right answer, and I encourage to seek legal advice from a competant attorney.
Five common types of business structures
First, here is an overview of the some of the most common structures for a small business:
1. Sole Proprietorship-this is the easiest type of business to start in that it does not require filing any forms, as long as there is one owner of a business operating in their own name.
2. General Partnership-when two or more persons join together to become owners in a business, a general partnership is formed.
3. Limited Liability Company or LLC -this entity is created by filing a Certificate of Formation with the Texas Secretary of State. Once formed, and if properly maintained, it offers its owners limited liability from the debts of their business.
4. Corporation-like an LLC, this entity also must be formed with the Texas Secretary of State and offers protection from liability for its owners.
5. Limited Partnership or LP– LPs and and other forms of partnerships can also offer limited liability under Texas law.
In a subsequent post, I will address more in depth the differences and pros and cons of these various entities. For now, you should understand that the first two structures, SOLE PROPRIETORSHIPS AND GENERAL PARTNERSHIPS, OFFER NO PROTECTION FROM PERSONAL LIABILITY FOR BUSINESS DEBTS.
You face real risk to your personal assets as a sole proprietor or general partner
Some of you may still be saying, “yeah, yeah, I know I could pay to form an entity, but its not worth the time, money and upkeep because my risk is low. Indulge me for a moment while I play “devil’s advocate” and give you some scenarios:
Example 1: You sell a Product
Imagine you serve as an independent consultant for a product manufactured by a third party and that product somehow causes harm to the person you sell it to. Let your imagination run wild, but think allergic reaction to a skincare product, or shoe getting caught in an escalator at the mall. The end result is that your customer sues not just the manufacturer of the product, but you as the seller.
Example 2: You are a Consultant or Coach
In this example, you aren’t selling a product that could hurt someone, but you are selling your experience and knowledge in a particular field like IT, marketing or health. Again, imagine that someone follows your advice, and instead of getting the results you promised, their website crashes, they don’t achieve their sales projections or they get sicker. Your client decides their failures are all your fault and sues you.
You can effectively mitigate risk to your personal assets by forming an entity for your business
Will forming an entity absolutely protect you from all potential personal liability related to your small business? No, like almost everything else in the law, nothing is absolute and there are exceptions to the rule. But forming and maintaining an entity is perhaps the simplest and most cost-effective step a small business owner can take to mitigate risk.
Leigh K. Freeman is a business law attorney, entrepreneur, wife and mom in The Woodlands, Texas and is responsible for the content of this blog post. You can check out her bio here: https://lkfreemanlaw.com/bio. This blog post is for information purposes only and shouldn’t be seen as legal or tax advice. Readers should consult with a licensed attorney before taking any action. Copyright 2019, Leigh K. Freeman attorney at law.
